Pricing power succumbs to weak demand, competition
The Numbers
CPI September 2009: Year over year 6.1% vs 6.4% in August
CPI September 2009: Month over month 0.4% vs 0.3% in August
Analysis
Though the CPI for September receded to 6.1% in September, it remained above the inflation target band. However, analysis shows that retailers’ pricing power finally succumbed to the pressures of the economic recession and the Competition Commission’s efforts to restore some form of competition in the South African economy.
Interest rate insensitive inflation
The rate of increase in interest rate insensitive inflation, which comprises some 53% of the CPI basket, was 50% slower than in January this year. This shows demand remained very weak despite the reduction of five percentage points in the repo rate since December last year. Consumers’ finances are under pressure as a result of mostly job losses. This is confirmed by the continuing weak performance of retail sales.
Impact of Problematic products
Another indication of retailers finally realizing that profit margins can’t be maintained through increasing price in order to neutralize lower sales volumes, stems from analysis which shows that the price increases of non-problematic and problematic CPI both declining.
Problematic CPI is defined as the prices of goods and services increasing by more than 15%.
Only six items with a combined weight of 9.4% qualified to be included in this category up to August. The increase in bank charges dropped sharply in September due to a high base as these prices were increased in September last year. This should however remain in the basket as the slower increase was only the result of base effects.
The CPI of these items increased by 17.2% in September – down from 19.5% in August. By excluding these items from the CPI the increase is only 4.9% compared to 7.1% in January and the current increase of 6.1% in the total CPI. See Table 1 below for an analysis of these items.
Table 1
Hot beverages (coffee, tea)
Tobacco
Electricity and other fuels
Recreational, cultural services
Financial services (bank charges)
Funeral services
CPI
% change
% change
% change
% change
% change
% change
% change
2009/01
23.25
12.65
30.47
5.3
17.1
19.4
8.1
2009/02
23.01
14.04
30.24
6.42
17.1
19.4
8.7
2009/03
26.33
13.47
30.09
19.92
19.62
19.4
8.6
2009/04
31.57
13.52
29.38
21.19
19.62
17.2
8.4
2009/05
33.08
13.37
29.57
20.95
19.62
17.2
8
2009/06
27.75
13.36
28.6
20.46
20.04
17.2
6.9
2009/07
26.42
15.98
27.38
20.34
17.8
15.08
6.7
2009/08
20.71
18.77
25.98
21.5
16.03
15.08
6.4
2009/09
16.5
17.3
24.9
20.1
7.8
14.2
6.1
Reasons for large increases
The large increase in the prices of hot beverages can be ascribed to bad weather conditions in Brazil last year which negatively impacted the harvest, as well as a high base of calculation.
Excise taxes are mostly responsible for the large increase in the prices of tobacco products.
The price increases in electricity stems from a shortage of this item in South Africa. Large price increases in for example tickets of sporting events are mostly responsible for the increase in the CPI for recreational and cultural services.
The slower increase in bank charges stems from a high base as already mentioned. However, the large increase in previous months can be attributed to banks probably trying to recoup lost income from lending operations.
The increase in the price of funeral services is probably due to capacity shortages.
Evidence from the Competition Commission’s efforts
A very good example of how the heat on an industry can impact its price behavior can be found in the food sector. According to the CPI, the prices of bread and cereals increased by 28% in January. As the Competition Commission stepped up its investigations, the price increasing pressures dwindled. In September the prices of bread and cereals were actually 2% lower (deflation) compared to a year ago. This is despite the increase of more than 30% in electricity tariffs previously highlighted by this industry as contributory reason for the high price increases.
Outlook
A strong recovery in consumer demand is not expected soon. Consumer demand will remain under pressure if electricity tariffs are increased by 45% next year. As a result retailers’ pricing power will not recover any time soon. Profit margins will have to be restored through savings, technology and higher productivity.
Interest rates
Even though the popular view is for interest rates not to be changed, the above analysis and price outlook suggest otherwise. Especially if the debate in inflation targeting called for by Minister Pravin Gordhan yields results calling for an upward shift in the target band.
